I)OLIcY RESEARCH WORKING PAPER 3146
The Price of Inconvertible Deposits
The Stock Market Boom during the Argentine Crisis
Eduardo Levy Yeyati
Sergio L. Schmukler
Neeltje Van Horen
T he World Bank
Development Research Group
Macroeconomics and Growth Division
October 2003
POLICY RESEARCH WORKING PAPER 3146
The Argentine crisis witnessed, among other things, a light of the impending risks. This boom was generalized
deposit run, the suspension of deposit convertibility, and to all stocks and more pronounced in liquid stocks.
a "boom" in the stock market. The authors argue that Furthermore, the boom was a symptom that deposits
this boom reflects the cost that depositors were willing to were effectively restricted and that investors were not
incur to get their money out of the banking system, in able to circumvent capital controls.
This paper-a product of Macroeconomics and Growth, Development Research Group-is part of a larger effort in the
group to understand financial crises. Copies of the paper are available free from the World Bank, 1818 H Street NW,
Washington, DC 20433. Please contact Emily Khine, room MC3-347, telephone 202-473-7471, fax 202-522-3518, email
addresskkhine@worldbank.org. Policy ResearchWorkingPapers are also posted on theWeb at http://econ.worldbank.org.
The authors may be contacted at ely@utdt.edu, sschmukler@worldbank.org, or nvanhoren@worldbank.org. October
2003. (11 pages)
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The
papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.
Produced by the Research Support Team
The Price of Inconvertible Deposits:
The Stock Market 1Boom during the Argentine Crisis
Eduardo Levy Yeyati Sergio L. Schmukler Neeltje Van Horen'
JEL Classification Codes: F3, Gl
Keywords: financial crisis; banking crisis; ADRs; Argentina; capital outflows
*Levy Yeyati is with Universidad Torcuato di Tella. Schmukler and Van Horen are with the World Bank.
E-mail addresses: ely@utdt.edu, sschmukler@worldbank.org, and nvanhoren@worldbank.ore. We are
grateful to Sebastian Auguste, Mike Dooley, Mike Melvin, and Luis Serven for helpful comments.
During 2001, Argentina faced a currency run that triggered a generalized bank
run.' As a result, Argentina suspended convertibility of their bank deposits on December
3 (the so-called "corralito"),7 and imposed extensive capital controls, measures that were
followed on January 7 by the devaluation of the peso and a compulsory "pesification"
and reprogramming of most bank deposits on February 3. Following the establishment of
the corralito, the stock market witnessed a "boom" in prices, in contrast with other recent
crises, resulting in a cumulative increase of the local stock exchange index of 64 percent
between the start of the corralito and the devaluation, and a further increase of 50 percent
by end-2002. Two recent papers by Auguste et al. (2003) and Melvin (2002) attribute
this seemingly unexpected development to a boom in stocks of companies with American
Depositary Receipts (ADRs) that may have been used as a channel for capital outflows.
In this note, we complement this new literature by showing that the price increase
was generalized to all stocks, including stocks with and without ADRs, and more
pronounced in liquid stocks. We also argue that this mechanism did not generate capital
outflows. Indeed, while ADR stocks did provide a way to migrate equity and obtain in
exchange dollars outside Argentina, at most only a small fraction of these stocks were
transferred abroad. Instead, the boom reflected the price investors were willing to pay to
cash out their inconvertible bank deposits, in light of the impending devaluation,
reprogramming, and confiscation risks. As a result, the boom could be interpreted as a
consequence of the effectiveness of both the suspension of deposit convertibility and the
capital controls.
1 See, for example, De la Torre et al. (2003) and references therein for an analysis of the crisis.
2 The name corralito ("little fence") was initially adopted because deposits couid be transferred freely
within the financial system but could not be redeemed in cash and leave the system, beyond a certain limit.
1
R. The coirralto and the stcsk nmnirket l$rDm
As shown in Figure 1, the corralito was preceded by a steady decline in reserves
and deposits during 2001. The cumulative slide in reserves from January 2001 until
November 2001 amounted to a loss of 10.9 billion dollars, paralleled by a loss of 11.5
billion dollars in deposits. The run peaked (possibly in anticipation of the coming
controls) on November 30, when deposits and reserves fell by 1.4 and 1.7 billion dollars
respectively. The imposition of the corralito, coupled with a ban on capital outflows,
significantly halted the decline in both deposits and reserves.3
If by November, the abandonment of the fixed parity was judged highly likely,
the corralito signaled the practical demise of convertibility and the question was no
longer whether a devaluation was inevitable, but rather what the post-devaluation
exchange rate would be. Moreover, the perception that the corralito had all but reduced
the incentives to run fueled beliefs that deposits would need to be (at least partially)
reprogrammed to avoid a banking collapse or hyperinflation, in the event the corralito
was lifted. Finally, the option to pesify deposits and loans, already under discussion in
policy circles, appeared ever more likely, as a way to avoid generalized defaults.
Consequently, the dollarization of deposits was no longer a realistic hedge against
exchange rate risk.4
There were at least three powerf'ul reasons to leave the corralito: i) the reduced
liquidity of bank deposits due to limited convertibility (only within the banking sector)
3While there were no restrictions on the purchase of dollar bills, right after the imposition of the corralito
the supply of dollars was increasingly rationed until December 21, when the foreign exchange market was
officially closed.
4 All of these beliefs eventually materialized. Most time and savings deposits (including those matured in
December and shifted to sight accounts) were reprogrammed at a longer duration and dollar deposits were
converted at the official (below market) 1.40 peso-dollar exchange rate.
2
that generated a "cash premium"; 5 ii) the possible reprogramming of deposits; and iii) the
impending devaluation in combination with a threat of pesification.
These reasons generated an increase in stock prices relative to inconvertible
corralito deposits. Stocks prices (with and without ADRs) were affected by all three
factors: stock prices were quoted in illiquid "corralito pesos,"6 stocks were
reprogramming-free, and stocks protected investors from a devaluation (as part of their
returns were tied to dollar revenues);
This is confirmed by the evolution of market capitalization-weighted portfolios of
ADRs and non-ADR stocks (Figure 2).7 A closer look reveals that the post-corralito
boom was more pronounced in liquid stocks: the top five most liquid stocks in the
portfolio (as determined by their average value traded in the period August 2001 -
September 2001) experienced a substantially larger price hike.' As a result, once we
restrict attention to the most liquid stocks, the evolution of both portfolios after the
imposition of the corralito exhibits a similar pattern.9
5 This premium was regularly measured as the discount rate on checks, which declined gradually as the
funds waiting to get out of the corralito fell over the year. By the time the corralito was lifted on December
2, 2002, the discount was about 2 percent. Unfortunately, data on this premium is only available starting in
February 2002.
6 An investor holding cash and willing to invest in stocks could have, for example, purchased a deposit at a
discount and use it to buy the stock. Alternatively, he could have bought the stocks cash, but at a discount.
7The results are not affected by the use of alternative weighting schemes.
8 We use value traded in August and September as the December and January values are affected by the
boom in prices. The results are robust to the use of different months to compute the weights.
9 As the top five ADR stocks are more liquid than the top five non-ADR stocks, one would naturally expect
that the price boost would be larger in the former, which was not the case. This seemingly contradicting
result can be explained by the fact that the price of ADR stocks in Buenos Aires is also a function of the
price of the ADR in New York, which remained relatively stable.
3
2A1R, cnpitRl contirois, Snd caphta otlows
As argued in previous papers, ADR stocks gave investors the option to exchange
inconvertible deposits for U.S. dollars in the international financial centers. However,
did this fund-shifting mechanism provide a way to circumvent the controls on deposits or
on capital outflows? And did investors actually use this fund-shifting alternative to get
fresh dollars abroad? We turn to these two questions next.
Even though ADR stocks allowed investors to migrate their stocks to New York,
this migration did not mean that controls were circumvented. On the contrary, in normal
times this migration is the counterpart of capital inflows to emerging markets, as
domestic stocks are exchanged for new funds invested in the country.'" While it is
unlikely that the capital obtained through migration was repatriated during the crisis, it is
still true that these transactions did not entail a decline in the overall level of deposits
(which would have been otherwise reflected in a loss of deposits and reserves).
Depositors that purchased stocks with inconvertible deposits simply transferred them to
previous stocks holders.
The absence of capital outflows can be observed in the data, both in quantities and
prices. As Figure 1 shows, after dropping significantly in the pre-crisis period, reserves
remained stable once the corralito and other controls were imposed. The drop in
deposits, reflecting the cash withdrawal within the limits of the corralito, translated into
an increase in currency in circulation.
The effectiveness o, capital controls is also apparent in the ADR premium (the
difference between prices of ADR stocks in Buenos Aires and ADRs in New York). As
10 Investors willing to invest in those countries demand their stocks in international equity markets, among
other things. See Claessens et al. (2002), Levine and Schmukler (2003), and the long literature cited
therein.
4
shown in Alaganar and Bhar (2001), under perfect integration the law of one price holds
as any price difference is instantaneously arbitraged away. By contrast, market
segmentation induced by capital controls, providing they are binding (hence, effective),
leads to the occurrence of a premium as full arbitrage cannot take place." The case of
Argentina is a good example; the premium was close to zero before the controls were
implemented and turned positive thereafter, gradually declining from around 50 percent
to a value of around 7 percent by the end of May (Figure 3).12
As ADR stocks were priced in corralito pesos while ADRs were priced in dollars
out of the corralito (and out of the country), the ADR premium reflected the three factors
previously described plus the premium induced by controls on capital outflows.'3
Accordingly, the evolution of the premium over time can be traced not only to the
realization of the reprogramining and exchange rate risks, but also to the weakening of
the cash premium (as the reprogramming of deposits and the steady leakage of un-
reprogrammed deposits slowly reduced the volume of corralito funds pushing for the
exit) and to the relaxation of other controls be end-2002.
Finally, note that, despite the absence of capital outflows, investors could have
still taken advantage of ADR stocks to move their funds out of the country through stock
migration. We argue that this occurred only to a limited extent. Figure 4 shows that the
average trading volume in ADRs in New York was high before the imposition of the
" The existence of controls does not prevent arbitrage across markets; it just means that the non-arbitrage
bands become wider so a non-zero discount can emerge. Depending on the type of control, a positive or
negative premium emerges. See Levy Yeyati and Schmukler (1999).
12 The premium is the percentage difference between the closing dollar price of the stock in Buenos Aires
and the closing price of the corresponding ADR in New York. Each stock in the portfolio is weighted by
its relative market capitalization.
13 A crude estimate of the latter is given by the ADR premium of around 15 percent by end-February (when
the reprogramming and exchange rate risks had already realized) minus a cash premium of about 9 percent
by the same date (as reported by the Central Bank of Argentina).
5
corralito, as investors kept selling Argentine stocks abroad while the crisis deepened.
With the corralito, by contrast, the trading of ADR stockls in Buenos Aires increased
significantly in relative terms, more than doubling the activity in New York (which also
represents trades among New York investors). This evidence indicates that only part of
the purchases of the underlying stock ended up being transferred abroad during the
period. Thus, this fund-shifting ADR-specific motive does not appear to have been a key
driver behind the stock mar.ket boom. 14
In sum, the evidence suggests that the boom reflected the desire of depositors to
shift their inconvertible deposits out of the banking system, although not necessarily out
of the country. In light of this, the boom (as well as the sizeable ADR premium that
accompanied it) was a manifestation that the controls imposed were effective.
14 Note that that the conversion of local shares into ADRs does not need to be reflected in the trading
volume, as investors can transfer their stocks from Buenos Aires to New Yorkc, increasing the number of
outstanding ADRs with no increase in trading. However, to convert their deposits into cash investors
would have needed to sell those ADRs, which would have added to the volume traded.
6
References
Alaganar, V. and R. Bhar, 2001, Diversification Gains from ADRs and Foreign Equities:
Evidence from Australian Stocks, Journal of International Financial Markets,
Institutions, and Money 11, 97-113.
Auguste, S., K. Dominguez, H. Kamil, and L. Tesar, 2003, Cr6ss-Border Trading as a
Mechanism for Implicit Capital Flight: ADRs, CEDEARs, and the Argentine
Crisis, previous version appeared as NBER Working Paper 9343, November
2002.
Claessens, S., D. Klingebiel, and S. Schmukler, 2002, The Future of Stock Exchanges in
Emerging Markets, Brookings-Wharton Papers on Financial Services, 167-202,
also available as CEPR Discussion Paper 3301.
De la Torre, A., E. Levy Yeyati, and S. Schmukler, 2003, Living and Dying with Hard
Pegs: The Rise and Fall of Argentina's Currency Board, Economia Spring 2003,
43-107.
Levine, R. and S. Schmukler, 2003, Migration, Spillovers, and Trade Diversion: The
Impact of Internationalization on Stock Market Liquidity, NBER Working Paper
9614.
Levy Yeyati, E. and S. Schmukler, 1999, Effects of Capital Controls on Capital Markets:
Evidence from ADRs, mimeo, The World Bank and Universidad Torcuato Di
Tella.
Melvin, M., 2002, A Stock Market Boom During a Financial Crisis?: ADRs and Capital
Outflows in Argentina, forthcoming, Economics Letters.
7
AIgnre a
EvOlunti@rm off Deposnts aldl Reseirves
Deposits in million of pesos Reserves in million of U.S. dollars
80,000 - Start of 30,000
f ~~~~~~~~~~~~~~~~Corralito
75,0D0 - Deposi - 25,000
70,0 -0 CCL 20,000
Payback
65,C000- - 15,000
60,000 - 10,000
Devaluation
and
55,000 - Pesification 5,000
Effect
50,000 I , ,, , o
Jan- ]Feb- Mar- Apr- May- Yun- Jul- Aug- Sep- Oct- Noov- Dec- Jan- Feb- Mar-
01 01 01 01 01 01 01 01 01 01 01 01 02 02 02
Deposits include dollar and peso deposits held by the private sector. Dollar deposits are converted into pesos using the
market exchange rate. The large jump in deposits on January 11, 2002 reflects the combined effect of the devaluation of the
exchange rate, increasing the peso value of dollar deposits, and the pesification of dollar deposits at the 1.4 conversion rate.
Reserves include gold and currency in possession of the central bank. The increase in reserves on September 10, 2001 is
due to the disbursement of an IMF loan, which was deposited in the central bank. The one billion U.S. dollar drop on
January 24, 2002 corresponds to the payback of the contigent credit line (CCL).
Sources: Bloomberg and Central Bank of Argentina
8
Figure 2
The Boom in the Stock Market
Price of ADR and Non-ADR Portfolios
Price index
Start of
25 0 .- -- ---- - - -- --- - - ---- - - ---
. ~~~~~~~~Corralito
250 -
2 0 0 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
1 5 0 - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - -_A R_- - - - - - - -
100 -- Nf-- ADR
50
Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02
Price of Different ADR Portfolios
Price index
350 ----------------------- Start of
Corralito
250 ~- -- - - -
200
150 - -- --
10 0 - - - - - - - - - - - - - - - - - - -
50 I I
Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02
Price of Different Non-ADR Portfolios
Price index
350 -- - - - - - - - - - -Start of _-- _--------___- _- __--------_-_--_-_--_-__ -_-_ -_-__-_ -__-_ -
Corralito
3 0 0 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - --- -- - - - - - ~-~ ~~~ ~~- - - - - - - - -
2 0 0 -- - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - - --_ _ _ _ , ^
1 50 - - - - - - - - - - - - - - - - - -T o p - - - - - - - - - - - - - - - -
100 - ==k H - -- - -- - -- - - - - - - - - - - - ------------
50 I I I
O'ct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02
The complete ADR portfolio includes all publicly listed ADR stocks (12 stocks), except Nortel which is highly illiquid.
The non-ADR portfolio includes 43 stocks, excluding stocks that were traded less than three days in the first month of the
corralito. The portfolio is market capitalization weighted, with the weight of each stock determnined by its average relative
market capitalization in the period August 2001-September 2001. Top five refers to the five stocks with the highest
average value traded in the period August 2001-September 2001. The top five ADR stocks includes Banco Frances,
Grupo Financiero Galicia, Perez Companc, Siderca, and Telecom Argentina. The top five non-ADR stocks includes
Acindar, Ledesma, Minetti Juan, Molinos, and Siderar. All stock prices are taken in pesos. Each index is equal to 100 on
November 30, 2001. The flat parts in the graph indicate periods of no trading, as the stock market was closed.
Source: Bloomberg
9
Fdsunre 3
Premium
60% -Start of
Corralito
50% r
40% -
30%
20%-
10%
0%
-10%
Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02
The graph plots the ADR premium for the portfolio of ADRs (12 stocks). The premium is the percentage difference
between the closing dollar price of the stock in Buenos Aires and the closing price of the corresponding ADR in New York.
The portfolio is market capitalization weighted, with the weight of each stock determined by its average relative market
capitalization in the period August 2001-September 2001. Note that during the sample period there were days when one of
the stock markets was closed. On those days, the premium from the last trading day is repeated. The peak premiwum
occurred on January 4, 2002, which coincides with the announcement of President Duhalde that the peg with the dollar
would be broken.
Source: Bloomberg
10
Figure 4
Trading in Buenos Aires and New York
T'rading volume in million of U.S. dollars
7 Start of
Corralito
6
5
4
3 - Buenos Aires
2 -llA New York
o0 I I ------
Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02
The figure shows the trading volume of the complete ADR portfolio (12 stocks), using the stocks with ADRs for Buenos
Aires trading and the corresponding ADRs for New York trading. The portfolio is market capitalization weighted, with the
weight of each stock determiined by its average relative market capitalization in the period August 2001-September 2001.
Onk days of no trading the trading volume of the previous trading day is repeated.
Source: Bloomberg
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